Capital gains tax on shares for a noob

[AlexC1981]

Hi All,

I'm trying to plan my future finances, but I'm stumbling around in the dark. I've just mastered the Future Value calculation in excel to work out compound interest on regular investments, but what I don't understand is the cost to buy and sell shares and capital gains tax. I have never invested in shares before apart from my pension contributions taken from my salary by my employer.

I'm thinking of long term savings over the next 10 years. Ignoring the big troughs of 2003, 2008 and 2020 it seems that 5% is a reasonable assumption to make as an annual increase averaged out over 10 years. I realise the percentage is extremely volatile, but I have to make some sort of assumption.

My little formula tells me that £2,600 invested monthly for 10 years at 5% gets me a cool £403,704 worth of shares in theory.

What happens when I want to turn it into money? I understand I can put in £20K per year as a stocks and shares ISA, which would cover two thirds of it. Does that £20K include my pension contributions? I understand there is a personal allowance of £12,500, but I assume that doesn't come into affect because it is eaten up by my salary?

I realise it is unlikely I would sell the whole lot in one go, but I need to understand how this works. The Calculate Capital Gains Tax calculator on the .gov website doesn't talk about ISA allowances, only the personal allowance.

I wouldn't be in a position to start this for a year or two anyway, so I'll presumably past the current Brexit/Covid volatility.

Thanks.

Edited by AlexC1981 on Saturday 19th September 17:12

Edited by AlexC1981 on Saturday 19th September 17:16

[Simpo Two]

AlexC1981 said:

What happens when I want to turn it into money? I understand I can put in £20K per year as a stocks and shares ISA, which would cover two thirds of it. Does that £20K include my pension contributions? I understand there is a personal allowance of £12,500, but I assume that doesn't come into affect because it is eaten up by my salary?

You're confusing allowances - income and capital gain. You have £12,500 income tax allowance (ie eaten up by your salary as you say) and £12,300 capital gains allowance as well. When you sell a share that's gain not income. You also have £2,000 dividend allowance to use.

That's as much as I can do, somebody cleverer than me will be along for the rest

[Mr Pointy]

Where to start. In general you have three types of investment accounts:

Pensions: can be via employer or a personal pension/SIPP & you can have both at the same time. Very tax effective on the way in, especially for Higher Rate taxpayers & those able to use salary sacrifice. Less tax effective when drawing out as the drawings are taxed, except for a tax free 25% lump sum. Locks the money away until you are 57 (& will move older with time). Maximum of £40k/year or your salary, whichever is smaller.

ISA: Maximum of £20k/year, less tax effective on the way in as there's no tax relief but very tax efficient on the way out as there is no tax on gains. There are people who are ISA millionaires & live tax-free on the income

GIA (General Investment Account): the poor relation as deposits are out of taxed income & capital gains are taxed, as you pointed out. You have a £12.5k CG allowance every year so one trick is to realise some gains (up to £12.5k) every year so you start the clock again. Note that almost any change you make to your investments is a "triggering event" which requires you to calculate any gain or loss & declare it in that tax year.

Shares: don't go there, at least as individual shares. The risk if far too concentrated unless you are an expert. Look at investing in funds which are (should be) run by mangers who can manage the fund to reduce risk & increase performance (well, that's the theory at least).

Before you start picking stocks & funds you need to draw up a life plan with major targets: emergency reserves, kids, moving house, when to retire etc etc.

There's a good thread here with links to lots of information for investors:
https://www.pistonheads.com/gassing/topic.asp?h=0&...

If you really have £31,200 a year to invest you probably need some good advice to maximise the return & minimise tax. You might care to read the sticky at the top of the forum:
https://www.pistonheads.com/gassing/topic.asp?h=0&...

[Simpo Two]

Mr Pointy said:

If you really have £31,200 a year to invest you probably need a boat too.

EFA

[xeny]

AlexC1981 said:

I realise it is unlikely I would sell the whole lot in one go, but I need to understand how this works. The Calculate Capital Gains Tax calculator on the .gov website doesn't talk about ISA allowances, only the personal allowance.

I wouldn't be in a position to start this for a year or two anyway, so I'll presumably past the current Brexit/Covid volatility.

Have a read of https://monevator.com/dont-wait-to-open-your-stock...

which in turn links to https://monevator.com/defuse-capital-gains-on-shar... which discusses approaches to minimising CGT liability.

[chip*]

I suggest you find a regulated financial planner specialist who will help you formulate a plan to cover all your life goals and objectives. Yes, you will need to pay a small fee for this regulated advice, but imo an invaluable piece of advice, and a fee worth paying when it's your financial future on the line.

[anonymous-user]

Investment is massively more beneficial if you make it tax efficient,

• Use your £20k annual ISA investment allowance. Tax free income and gains. The cumulative benefit is enormous.
• Make sure you're doing what you can with pension. Tax relief going in, tax free compounding, 25% tax free coming out, remainder at your marginal rate.
• Use your annual CGT allowance religiously. £12,300 may not look much but across a couple of decades it's £250,000!

Juggle things carefully and you should be able to combine the three points above into a very good outcome. I wouldn't try to be clever, just apply some discipline and do the basics.

[AlexC1981]

Thanks all. Your comments have helped fill in quite a few gaps in my knowledge I didn't know I had! I have started reading the suggested links.

Mr Pointy said:

Before you start picking stocks & funds you need to draw up a life plan with major targets: emergency reserves, kids, moving house, when to retire etc etc.

This is what I'm trying to do. I paid off the flat I live in a few years ago and feel like I have been paralysed by indecision since then as to whether or not I should try to keep the flat when I upgrade to a house. The stamp duty relief has prompted me that I need to finally make my mind up. I don't want the added work of looking after a tenant, so I'm hoping I can make the numbers stack up with shares.

Sorry, this is coming away a bit from my original question, but typing this out helps me to get my head around it all.

The pros and cons of the two options would be:

1. Sell the flat to buy the house, which would be paid within two years and no stamp duty to pay when I buy it.
2. There is much peace of mind in knowing the place you live in is paid for.
3. Then start investing into shares each month and hopefully see decent growth with compound interest. (Alternatively this plan could be modified to pay the mortgage off slower and start investing earlier. I could also consider having a larger mortgage in favour of keeping some of my existing cash ISA, but that's an exercise for another day!)
4. The considerable risk and worry associated with share price volatility. If we are going through a bad spell I might not be able to access the money for years unless I accept a loss.
5. The reduced capital gains tax because when I stop working I would only take out a portion of the value annually, so I'd benefit from the £12,300 allowance.
6. Not having a debt to service would give me the freedom to enjoy my earnings should I chose not to invest for a period or my personal circumstances change.

Vs.

1. Big mortgage on house so more interest payments.
2. 3% stamp duty to pay on house.
3. Rental income from the flat that gets highly taxed.
4. Appreciation of the flat value, but would be highly taxed when I sell it because the entire value of the appreciation would only get offset against one years worth of capital gains allowance.
5. The risk and extra work that comes with having a tenant. If I went down that route I would want to be as hands off and as safe as possible so I'd probably pay a lot in management fees and insurance.
6. The money would be locked away in the flat, so not easily accessible.

I have a lot of number crunching and research to do yet before I can make an informed decision, but I'm determined not to put this off any longer.

Simpo Two said:

Mr Pointy said:

If you really have £31,200 a year to invest you probably need a boat too.

EFA

I think it's more that my outgoings are very low rather than earning loads! I hope I didn't come across the wrong way.

Edited by AlexC1981 on Sunday 20th September 09:27

[Simpo Two]

AlexC1981 said:

I think it's more that my outgoings are very low rather than earning loads! I hope I didn't come across the wrong way.

Not at all, my route to fame and fortune was the same - low overheads and low outgoings. Being self-employed and not knowing how much I'd earn each year made me cautious, and I'm a natural saver. Bizarrely now I'm in a position to take higher risk!

[AlexC1981]

OK, I think I've finished working things out on the shares option. I've worked on the basis that I'll pay into it for 10 years, then I will pay myself an income from it for the next 20 years by selling an amount of shares per month. I don't plan on retiring in 10 years, but this is my basis for when I compare against keeping the flat.

I *think* capital gains tax can be avoided by using the ISA wrapper and any share gains made outside the wrapper could be sold over 2 years to avoid paying any tax.

Does this all look correct and is 5% a reasonable figure to work with?

If so, it is incredible that you can pay in a value per month for 10 years, then withdraw the same value for the next 20.

[Mr Pointy]

I'm not sure you've accounted for the fact that the funds in the ISA & GIA accounts could/should still be growing at 5% for the 20 years of decumulation. I trust you aren't just going to withdraw it all to cash at the end of 10 years & leave it there for the next 20.

You might also want to consider the effect of inflation on the buying power of £2,600 in 30 years time! If you want the buying power of the monthly withdrawal to stay the same you need to increase it by some amount (2%?) each year.

[AlexC1981]

After looking at the calculators on Hargreaves Lansdown, Welthify and Nutmeg, it seems 5% is too optimistic so I am going to use 3.5% going forward. This means I need to adjust my withdrawal period to 15 years instead of 20.

Mr Pointy said:

I'm not sure you've accounted for the fact that the funds in the ISA & GIA accounts could/should still be growing at 5% for the 20 years of decumulation. I trust you aren't just going to withdraw it all to cash at the end of 10 years & leave it there for the next 20.

You might also want to consider the effect of inflation on the buying power of £2,600 in 30 years time! If you want the buying power of the monthly withdrawal to stay the same you need to increase it by some amount (2%?) each year.

I think for the exercise I am doing I don't need to enter inflation for the moment. This is enough to give me a fair comparison, but I will think about adding it in afterwards.

The formula should take into account that it will still grow in the withdrawal period. It's basically the reverse of the compound interest formula. 20 years x 12 months x £2,600 is actually a total of £624,000 withdrawn. I need to find a way to verify I've worked it out correctly though. I wouldn't want such a major decision in my life to be influenced by dodgy maths

I used the first answer here:

https://money.stackexchange.com/questions/75867/ca...

. said:

To calculate the balance (not just principal) remaining, type into your favorite spreadsheet program:

=FV(Rate,Periods,Withdrawal,PV)

Rate = type in the MONTHLY interest rate (so, if you expect to get 6% per year,
type in 6%/12 or 0.5%)
Periods = type in the number of MONTHS elapsed since the initial investment
Withdrawal = type in as a POSITIVE number the monthly withdrawal amount
PV = type in as a NEGATIVE number the (present) value of the initial investment

It is important that the periods for "Periods" and "Rate" match up. If you use your annual rate with quarterly periods, you will get a horribly wrong answer.

So, if you invest $1000 today, expect 6% interest per year (0.5% interest per month), withdraw $10 at the end of each month, and want to know what your investment balance will be 2 years (24 months) from now, you would type:

=FV(0.5%,24,10,-1000)

And you would get a result of $872.84.

[anonymous-user]

I've been a pretty successful investor but all of this sounds a bit "clever" for me.

Do the basics, maximise tax efficiency and keep your fingers crossed.

After the financial crisis of 2008 I thought, "Well, we're looking at a decade or more of pretty subdued equity returns but I might as well stay invested for the time being if interest rates are going to sit as low a 2% for a few years". How wrong I was! Not complaining though - and there's no prize for 20:20 hindsight.

[AlexC1981]

Fair comment, but I have to try to work out a few different projections to see roughly where I could end up.

If anyone could check I've done those figures above correct I would really appreciate it

I've been working on the BTL comparison calculations this morning, which is even less fun as I have to take into account extra mortgage interest paid, rental income, expenses, appreciation, capital gains tax and the residents relief, surplus money not going on the mortgage that could be invested in an ISA, all the years I'll miss out on the full ISA tax wrapper etc.

[Mr Pointy]

AlexC1981 said:

I've been working on the BTL comparison calculations this morning, which is even less fun as I have to take into account extra mortgage interest paid, rental income, expenses, appreciation, capital gains tax and the residents relief, surplus money not going on the mortgage that could be invested in an ISA, all the years I'll miss out on the full ISA tax wrapper etc.

From what you have said it seems as if you're in danger of being almost an accidental landlord, & those are the focus of all of the latest clampdowns the government has brought in.

Having just one rental property is tantamount to buying only one company's shares; it's far too focused. One bad tenant or void period & all of your income is wiped out. Just because you like your flat to live in doesn't necessarily make it a good rental property. It might be better to look at buying three of four cheaper properties so your risk is spread a bit.

[TallTom]

Also... forgetting any share dividends.... or is that included in the 3.5% 'Interest'?

[AlexC1981]

Mr Pointy said:

From what you have said it seems as if you're in danger of being almost an accidental landlord, & those are the focus of all of the latest clampdowns the government has brought in.

Having just one rental property is tantamount to buying only one company's shares; it's far too focused. One bad tenant or void period & all of your income is wiped out. Just because you like your flat to live in doesn't necessarily make it a good rental property. It might be better to look at buying three of four cheaper properties so your risk is spread a bit.

I thought insurance would cover a bad tenant? The rental income would be very low after expenses and tax. The main benefit seems to be in selling it later on as property appears to double in value every 10 years. That's certainly the case for my flat since I bought it 10 years ago and Crossrail will be coming in a few years.

This is probably the hardest decision I've ever had to make. If I actually wanted to be a landlord it would be easier, hence I have to work out if it really is worth the effort.

TallTom said:

Also... forgetting any share dividends.... or is that included in the 3.5% 'Interest'?

I suppose I should have called it growth rather than interest, but I am new to all this! The 3.5% came about by looking at projections on the investment websites I mentioned. They didn't say anything about dividends.

[xeny]

AlexC1981 said:

I suppose I should have called it growth rather than interest, but I am new to all this! The 3.5% came about by looking at projections on the investment websites I mentioned. They didn't say anything about dividends.

Looking at https://www.courtiers.co.uk/news-and-insights/barc... - the real returns section of fig 9, 3.5% seems a bit low, unless that is after fairly exorbitant fees?

[AlexC1981]

It would be after fees because I changed the percentage based on Wealthify's projection for £2600 invested monthly at "ambitious" level (level 4 out of 5), which estimates a return of £299,077 worst, £379,691 anticipated, and £482,589 best.

Nutmeg say they get 6.2%AR and their projections work out to roughly the same. It's hard to say because they show you a graph rather than specific numbers.

Hargreaves Lansdown say they get 5% at medium growth rate or 8% at high. Their calculator will only show me over a 20 year period so not very useful.

I'm a bit puzzled by it because that does appear to make the fees quite a lot. My formula needs 3.5% to generate the a figure around £372,924, which is similar to Wealthify. I have verified the formula works by using a website that calculates compound interest.

[Simpo Two]

AlexC1981 said:

I thought insurance would cover a bad tenant? The rental income would be very low after expenses and tax. The main benefit seems to be in selling it later on as property appears to double in value every 10 years. That's certainly the case for my flat since I bought it 10 years ago and Crossrail will be coming in a few years.

This is probably the hardest decision I've ever had to make. If I actually wanted to be a landlord it would be easier, hence I have to work out if it really is worth the effort.

Being a landlord is not an investment, it's a job, and not an easy one. The area has its own regulations and risks. I once found myself playing 'accidental landlord', chose a tenant that seemed perfectly fine - and yet after two years it went bad. She had to be evicted, and lost rent and repairs cost me £4K. So I thought 'fk that, it will be easier if I sell the house and invest the proceeds'. No hassle, and at least as rewarding financially.